Friday, February 12, 2016

Everybody's Going Negative Weekly Market Update: Everybody's Going Negative
Fri, 12 Feb 2016 16:16 PM EST

Volatility shook global markets this week as participants grappled with a non-stop series of confidence-shaking developments. In Europe, jitters about the solidity of bank capital levels drove shares of Deutsche Bank down as much as 10% at one point and undercut broader equity indices. Meanwhile, Greece appeared to backtrack on pension reform commitments, compounding the worries about Europe. In the US, Fed Chair Yellen's Congressional testimony revealed little about the chances of more rate hikes this year, however her words of caution about the US economy added weight, strongly inferring the Fed will keep rates on hold in March. The dollar weakened further as markets all but priced out the chances of Fed hikes this year, driving the biggest monthly decline in USD/JPY since Oct 2008 and further strength in the euro. Mainland Chinese markets were closed all week for the Lunar New Year, but on Thursday, Hong Kong's Hang Seng opened for trade and plunged 3.9%, catching up with the western selloff. Crude prices hit 15-year lows on talk that an OPEC/non-OPEC production deal was dead, then saw 10% gains Friday on talk the deal was back on, whipping around energy stocks along the way. Concerns about the banking sector drove gold prices to a one year high, briefly rising above $1260 while Treasury yields tumbled. The US curve reached its flattest levels since 2008 when the spread between the US 2 and 10-year yields fell below 1.00%. For the week, the DJIA slumped 1.4%, the S&P dropped 0.8%, and the Nasdaq lost 0.6%.

During her two days of Congressional testimony, Fed Chair Yellen repeated her firm stance that it would be premature to draw any conclusions about deteriorating market conditions or make judgements about what the Fed might do in March. However, she affirmed that market conditions would play a big role in the March decision. Regarding the strength in employment, Yellen cautioned that job creation has been skewed toward lower paid sectors, with the data giving only tentative signs of wages rising.

In light of moves by the BOJ and ECB, Yellen was asked repeatedly whether negative rates were in the realm of the possible for the Fed. She would not rule out the use of negative rates as part of the Fed toolkit if conditions worsen, but said the issue required more study. Interestingly, Yellen disclosed that the Fed had considered going negative in 2010 but decided it wouldn't be the best course at that time. As of Friday, Fed fund futures were pricing only about a 25% chance of one rate hike in December.

The greenback continued to weaken against its major pairs as markets pushed forecasts for Fed hikes out further and further. Meanwhile, flight-to-safety and the unwind of the short yen/long Japan stocks trade continued to drive the yen higher; the currency has gained nearly 9% against the dollar since the BoJ adopted negative rates in late January. USD/JPY dropped to 15-month lows early on Thursday, drawing strong verbal intervention from Japanese officials. As the pair dropped below 112, there were rumors the BoJ was checking rates - marking the first intervention by the bank since summer 2014 - then on Friday BoJ Chief Kuroda and various cabinet officials met to discuss the situation. USD/JPY rose off the ~111.00 lows on the verbal intervention, but not by much. The euro also kept gaining against the dollar, with EUR/USD nearly reaching 1.1400 on Thursday, for fresh four-month highs.

China's foreign reserves decline was nearly as bad as expected in January, confirming fears that Beijing is rapidly burning through cash in its attempts to prop up the yuan and the Chinese economy. Total reserves fell for the third straight month to a three-year low in January, although the decline of $99.5B was less than the record high $107.9B in December. The total reserves stand at $3.23 trillion, however analysts estimate that liquid, accessible reserves could be as low as $2 trillion. Noted China skeptic Kyle Bass said that the nation's liquid foreign reserves were already below a critical level and China's back was already up against the wall. With Chinese markets closed all week for the Lunar New Year, there were no yuan fixings, although the offshore yuan rose to a two-month high of 6.5272.

Sweden's Riksbank unsettled markets at its scheduled policy meeting on Thursday by cutting rates even further than expected into negative territory. The central bank cut its main repo rate by 15 bps to -0.50% (expectations were for a 10 bps cut) and commented it felt forced to act because of "weakening confidence" in achieving its inflation target of 2%. There was a familiar split in European sovereign rates after the move, with core UK, German and French 10-year yields dropping to fresh record lows, while peripheral yields moved higher.

The Greece crisis has returned to headlines, providing a familiar source of deep uncertainty for European markets. On Friday, February 5th, talks on the ongoing Greek pension reform process between Athens and its European creditors ended on a very bad note. On Monday, the Athens stock exchange fell nearly 9%, dropping to its lowest level since 1990, its fifth consecutive day of losses. The creditors said the budget gap for 2016 was too big and the government had no credible strategy for fixing the deficit. Greek officials were still stonewalling their European partners as of Friday. Yields on the sovereign debt of Spain, Portugal and Italy follow a predictable pattern, as peripheral debt sold off.

Peripheral jitters were not the only problem for Europe this week, as contingent convertible bonds (CoCos) emerged as a big worry for the banking sector. On Monday, Cantor Fitzgerald published a note overflowing with concerns about Deutsche Bank's CoCos, which carry relatively high yields and allow the bank to skip payments and in certain cases convert the notes to equity in times of stress without causing a default. Cantor and others are worried that market shocks might force European banks to stop paying coupons, and investors have been dumping the instruments over recent weeks, undermining confidence in bank capital levels and sending certain bank CDS much higher. Frankfurt-traded shares of Deutsche Bank tanked 12% in the two days after the Cantor note, then gyrated up and down in double digit percentage moves through the week as rumors circulated that the bank would buy back billions in senior debt. The $5.4 billion tender was officially announced on Friday, and shares of DB firmed up. Shares of other major banks followed DB higher, and they were also helped by a report that JP Morgan CEO Jamie Dimon recently bought 500K shares of his own bank's stock.

Shares of the second largest natural gas producer in the United States, Chesapeake Energy, collapsed on Monday after reports made the rounds that the firm had hired Kirkland & Ellis, a law firm that specializes in restructuring. The company issued a statement asserting that Kirkland & Ellis LLP has served as one of the firm's outside counsels since 2010 and claimed the company has no plans to pursue bankruptcy. But the damage was done: shares of CHK fell 50% on Monday and only recovered a fraction of the loss through Friday as commentator suggested some form of bankruptcy or restructuring is the most likely outcome given the firm's huge debt load. Meanwhile, Anadarko cut its dividend 82% to conserve cash.

Earnings season is about 2/3 over at this point, with the bulk of the DJIA and S&P500 components out of the way. Disney fell 4% to 12-month lows despite widely topping earnings and revenue expectations, as investors zoomed in on shrinking ESPN profit levels. Coca-Cola's organic revenue declined y/y while its total concentrate sales fell 3%, however profits held up thanks to higher pricing. Cisco saw 10% gains on the week after its net income rose more than 25% y/y and earnings topped expectations. Tesla disclosed a big loss in its fourth quarter, however the firm's ambitious 2016 deliveries forecast and solid Model S deliveries more than made up for it. Twitter hit new all-time lows after disclosing very poor fourth-quarter user growth metrics. Mylan tanked 20% after its earnings miss and announcing it agreed to pay nearly $10B for Sweden's Meda.